Pensions shake-up 'to hit middle-earners'

MILLIONS of middle-income earners face a new 'stealth tax' under plans to reform the state pension system.

Under the proposed changes, those currently earning more than £18,000 a year will see a key part of their state pension provision almost halved, while taxes continue to rise.

The plans for reform, to be unveiled tomorrow, will include a restoration of the link between earnings and the basic state pension.

But the Government is also expected to accept little-noticed proposals from its pensions czar, Lord Turner, to change the state second pension (S2P). It is a top-up pension paid by the state in addition to the basic state pension.

Anyone who is paying National Insurance contributions currently builds up an S2P, unless they choose to have a rebate paid into a private pension. How much it is worth depends on how much you earn over your working life up to a maximum threshold and how many years of NI contributions you build up.

For those who earn and pay in most, it is worth £110 a week on top of the basic state pension. But the Government is planning to freeze the maximum pay level up to which rights to the S2P accrue - currently just over £34,000. There are no plans, however, to freeze the amount on which NI contributions are payable.

The result is that people will increasingly pay contributions on part of their salary for which they will receive no pension benefit in return.

A study for the Tories by insurer Aegon suggests that someone on £ 18,000 today will be on £34,000 by 2033, assuming annual earnings growth of 4.5 per cent, meaning they will fall into the tax trap - making contributions for which they get nothing back.

The Conservatives said someone earning £35,000 today can expect to be paying £2,119 more in NI contributions by 2033 for a pension benefit they would no longer receive.

Tory pensions spokesman Philip Hammond said: 'This amounts to another stealth tax on middle-income earners, which will hit them very hard. Even someone on £18,000 will feel the bite of this stealth tax.

'At present, nearly half of employee NI contributions go towards an earnings-related second pension. Under the Government's proposals, that contribution will become a straight tax on income above about £18,000 a year.'

He said that at present, anyone can 'contract out' of the S2P and take their contribution to it into a private scheme. But this right, too, will be abolished.

Steven Cameron, head of business regulation at Aegon, said: 'The state second pension will gradually become a flat-rate benefit because of these changes.

'Instead of getting £110 a week, middle earners will get only £60. But the big issue is they will continue to pay the same NI contributions. We aren't trying to score party political points, but this change has got to be properly debated.'

However, a Department for Work and Pensions source insisted that the proposed changes would 'simplify the nightmarishly complex state second pension'.